Banca d’Italia. A note on the effects of residential property price growth on bank profitability

Since the global financial crisis the European banking sector has been experiencing a period of low profitability. Despite some recent improvements in asset quality, especially in countries that were hit harder by the sovereign debt crisis, the return on equity of European banks is far from pre-crisis
levels: in 2018 it was 6 per cent, well below the level of 2007 (10 per cent).
While on average the euro area and the UK banking sectors show a sizeable profitability gap relative to the US, there is significant cross-country heterogeneity within Europe with some well-known exceptions such as the Nordic countries. A recent ECB analysis points to structural factors as the main driver of low profitability. However, the extent to which these differences depend on the structural efficiency of banks or on cyclical economic developments at the national level remains an open question.
In terms of cyclical factors affecting banks’ profitability, real estate dynamics play a prominent role. It is noteworthy that since the global financial crisis property prices have grown at a rapid pace in some European countries only, while in others they have, on average, stagnated. This note explores the effects of the real estate cycle, proxied by residential property real price growth, on bank profitability. The main objective of the analysis is to quantify to what extent cross-country differences in European bank profitability may depend on different developments in property prices.

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